Especially since the operational introduction as central bank monetary policy framework in the early 1990s in New Zealand, the United Kingdom (UK), Canada and Sweden, inflation targeting has gained both empirical and theoretical relevance as a monetary policy strategy. In this paper I relate to inflation targeting theory and its framework in the UK. For that
purpose I first regard the development of inflation targeting in respect to other monetary policy strategies in sections (2.2) and (2.3). I will answer the question what the actual target variable is and why one would want to have inflation being low and stable. Then there is some complexity because the development of inflation targeting has to be viewed in
relation to paradigmatic debates between Monetarist and New-Keynesian insights. In the sections (2.4) and (2.4) I present the two fundamental views of how an inflation targeting framework should be modelled. By stating some equations from basic theoretical literature, I try to give a overview about the different characteristics of that monetary policy strategy and how there is still controversy about the way of modelling. Chapter (3) is concerned
with the operational framework in the UK, including statements to historical developments at the Bank of England in section (3.1). In particular, gaining of operational independence in setting interest rates—section (3.1.5)—was an important step for the Bank. The present monetary policy framework will be reviewed in section (3.2), in detail relating to the Bank’s
publication policy—section (3.2.2)—and the inflation forecasting process—section (3.2.3). The Bank of England’s model of the transmission mechanism is reviewed in section (3.3). This includes the interest rate setting process, the role of money and the relationship between inflation and inflation expectations. Finally, I discuss some economic effects that
changed the British economy since the introduction of inflation targeting—section (3.4).
Table of Contents
1 Abstract
2 Modelling Inflation Targeting
2.1 Introduction
2.2 Monetary Policy
2.2.1 Monetary Policy Strategies in Theory
2.2.2 Monetary Stability as an Aim of Monetary Policy
2.2.3 Empirical Monetary Strategies
2.2.4 Monetary Transmission Mechanisms
2.3 Inflation Targeting as Monetary Policy Strategy
2.3.1 Characterisation
2.3.2 The Origins
2.3.3 On Transparency
2.3.4 Form of the Target and the Policy Horizon
2.3.5 Asset Price Bubbles and Rapid Expansion of Credit
2.3.6 Critical Discussion
2.4 The Instrument Rule Model
2.4.1 Modelling Inflation Targeting
2.4.2 Kydland and Prescott’s Time Consistency Problem
2.4.3 Barro and Gordon Introduce Reputation to the Game
2.4.4 McCallum and the Monetary Base
2.4.5 The Taylor Rule For Interest Rate Setting
2.4.6 Asymmetric Preferences and Non-linear Taylor Rules
2.4.7 Summary
2.5 The Target Rule Model
2.5.1 Svensson’s Model in the New Keynesian Framework
2.5.2 Some Aspects in Critical Discussion
2.6 Summary
3 The Process of Inflation Targeting in the UK
3.1 Some Historical Issues
3.1.1 Development of the Bank of England
3.1.2 Previous Monetary Policy Regimes
3.1.3 Adoption of Inflation Targeting
3.1.4 Operational Framework from 1992 - 1997
3.1.5 Bank of England Operational Independence
3.1.6 Summary
3.2 Present Monetary Policy Framework at the Bank of England
3.2.1 Core Purposes and Monetary Strategy
3.2.2 The Bank’s Publication Policy
3.2.3 Forecasting Inflation at the Bank of England
3.3 Bank of England Transmission Mechanism
3.3.1 The Transmission Mechanism in Overview
3.3.2 Interest Rate Setting Process and Quantitative Effects
3.3.3 Financial Markets and Spending Behaviour
3.3.4 From Changes in Spending Behaviour to GDP and Inflation
3.3.5 The Role of Money
3.3.6 Relationship between Inflation and Inflation Expectations
3.4 Effects of Inflation Targeting in the United Kingdom
3.4.1 Introduction
3.4.2 Basic Economic Developments After Inflation Targeting
3.4.3 Inflation Targeting and the Exchange Rate
3.4.4 Empirical Evidence of a Non-linear Taylor Rule
3.4.5 Efficacy and Impact on Social Welfare
3.4.6 Inflation Targeting and The Household Sector After the Financial Crisis
3.4.7 Expected Inflation as a Metric of Heightened Credibility
3.5 Concluding Remarks
4 Conclusion
Objectives and Research Focus
This thesis examines the theoretical foundations of inflation targeting as a monetary policy strategy and evaluates its practical implementation and economic impacts within the United Kingdom. The primary research goal is to understand how inflation targeting has influenced the British economy, specifically regarding price stability, institutional transparency, and the Bank of England's operational framework.
- Theoretical analysis of Monetarist versus New-Keynesian approaches to inflation targeting.
- Evaluation of operational frameworks, including the move toward Bank of England independence.
- Assessment of the monetary transmission mechanism and the role of inflation forecasts.
- Investigation into the empirical effectiveness of inflation targeting and its impact on social welfare.
- Examination of challenges posed by asset price bubbles and financial instability.
Excerpt from the Book
2.3.5 Asset Price Bubbles and Rapid Expansion of Credit
The appropriate response of monetary policy to asset price bubbles and any associated rapid expansion of credit is a matter of debate amongst central bankers and monetary economists. In the aftermath of the collapse of the dot-com bubble and the more recent wider correction to international share values, a number of commentators have argued that the achievement of price stability by central banks may be associated with heightened risks of financial instability, too. They argue that central banks should not focus solely on inflation prospects, but also take account of developments in asset prices, debt and other indicators. They may be symptomatic of incipient financial imbalances which is neatly summarised by Crockett (2003):
“(I)n a monetary regime in which the central bank’s operational objective is expressed exclusively in terms of short-term inflation, there may be insufficient protection against the build up of financial imbalances that lies at the root of much of the financial instability we observe. This could be so if the focus on short-term inflation control meant that the authorities did not tighten monetary policy sufficiently pre-emptively to lean against excessive credit expansion and asset price increases. In jargon, if the monetary policy reaction function does not incorporate financial imbalances, the monetary anchor may fail to deliver financial stability.“
Chapter Summary
2 Modelling Inflation Targeting: This chapter reviews theoretical literature on inflation targeting, comparing different model specifications and the debate between rule-based and discretionary monetary policy.
3 The Process of Inflation Targeting in the UK: This chapter analyzes the historical evolution of the Bank of England's framework, including the transition to operational independence and the mechanisms used to control inflation.
4 Conclusion: The final chapter summarizes the findings, noting that while inflation targeting has improved transparency and stability, it faces ongoing challenges from asset price volatility and financial crises.
Keywords
Inflation Targeting, Bank of England, Monetary Policy, Price Stability, Taylor Rule, Financial Stability, Monetary Transmission Mechanism, Interest Rate Setting, Transparency, Credibility, Asset Price Bubbles, New-Keynesian Framework, Economic Growth, Central Bank Independence.
Frequently Asked Questions
What is the core focus of this research?
This work provides an in-depth analysis of inflation targeting as a monetary policy framework, with a specific focus on the development, implementation, and economic consequences of this strategy in the United Kingdom.
What are the central themes discussed in the thesis?
The key themes include the theoretical modeling of inflation targeting (instrument rules vs. target rules), the historical transformation of the Bank of England, the role of transparency, and the relationship between inflation targeting and broader financial stability.
What is the primary objective of the inflation targeting strategy?
The primary goal is the achievement and maintenance of low and stable inflation, which serves as a nominal anchor for the economy and facilitates long-term price stability.
Which scientific methods are employed?
The thesis utilizes a literature-based theoretical review, analyzing mathematical models (such as Taylor rules and Svensson’s models), alongside an empirical examination of institutional developments and historical economic data from the UK.
What topics are covered in the main section?
The main part covers the theoretical origins of inflation targeting, the operational framework of the Bank of England, the mechanics of the monetary transmission process, and an evaluation of the effects on the British economy.
Which keywords characterize this paper?
Key terms include Inflation Targeting, Bank of England, Monetary Policy, Taylor Rule, Financial Stability, and Central Bank Independence.
How does the Bank of England define 'monetary stability'?
Monetary stability is defined as maintaining stable prices and confidence in the currency, which the Bank achieves by setting interest rates to meet the government's inflation target.
What is the significance of the 1998 Bank of England Act?
This act was a revolutionary step that granted the Bank of England operational independence to set interest rates, thereby significantly enhancing its credibility and accountability in achieving inflation targets.
Does the paper conclude that inflation targeting is infallible?
No, the author notes that while inflation targeting has contributed to stability, recent challenges—such as asset price bubbles and financial crises—highlight the limitations and ongoing complexities of the framework.
- Citation du texte
- Benjamin Viertel (Auteur), 2008, Inflation Targeting in the United Kingdom, Munich, GRIN Verlag, https://www.grin.com/document/118400
